Test bank cost accounting 6e by usry 24 decision making under uncertainty

The Social Club plans to apply the expected value decision rule criterion to determine the number of cups of hot cider to stock.. sum of the conditional profit loss of each event times

DECISION MAKING UNDER UNCERTAINTY

MULTIPLE CHOICE

Question Nos 1, 2, and 19 are AICPA adapted.

Question Nos 4-6, 8-11, and 14-17 are ICMA adapted.

Question Nos 7, 12, 13, and 18 are CIA adapted

A 1 Which of the following best identifies the reason for using probabilities in capital budgeting

decisions?

A uncertainty

B cost of capital

C time value of money

D projects with unequal lives

E all of the above

D 2 In probability analysis, the square root of the mean of the squared differences between the

conditional values and the expected value is the:

A objective function

B optimum corner point

D standard deviation

E none of the above

E 3 Which of the following utilizes statistical sampling techniques in capital budgeting in order to

obtain a probabilistic approximation of the profitability of a capital expenditure proposal?

A sensitivity analysis

B decision tree

C linear programming

D probabilistic budgeting

E Monte Carlo simulation

B 4 The Social Club plans to apply the expected value decision rule (criterion) to determine the

number of cups of hot cider to stock The expected value is the:

A sum of the conditional profit (loss) for each event

B sum of the conditional profit (loss) of each event times the probability of each event occurring

C conditional profit (loss) for the best event times the probability of each event occurring

D sum of the conditional opportunity loss of each event times the probability of each event occurring

E revenue less the costs

102

D 5 The Social Club plans to use a payoff table to apply the expected value decision rule (criterion)

to determine the number of cups of hot cider to stock The Social Club would select the demand level that:

A is closest to the expected demand

B has the greatest probability of occurring

C has the greatest expected opportunity loss

D has the greatest expected monetary value

E includes the event with the greatest conditional profit

E 6 The Social Club plans to apply the expected value decision rule (criterion) to determine the

number of cups of hot cider to stock The maximum expected value of additional information

is the:

A same as the expected profit under certainty

B sum of the conditional profit (loss) for the best event of each act times the probability of each event occurring

C difference between the expected profit under certainty and the expected opportunity loss

D difference between the expected profit under certainty and conditional profit for the best act under certainty

E difference between the expected profit under certainty and the expected monetary value

of the best act under uncertainty

C 7 Solutions provided by quantitative techniques based on probabilities should be considered to

be:

A numerically precise and correct

B approximations based solely on past experiences

C the best estimate of expected results

D unaffected by environmental changes

E none of the above

C 8 Decisions are frequently classified as those made under certainty and those made under

uncertainty Certainty exists when:

A the probabilities for each outcome of an event can be assigned with a high degree of confidence

B the probability of the event is less than 1

C there is absolutely no doubt that an event will occur

D there is more than one outcome for each possible action

E the standard deviation of an event is greater than 0

C 9 Barkley & Co has been sued by a client for breach of warranty Barkley's controller has

accumulated data from the outcomes of similar cases Barkley & Co can best quantify its exposure to a loss in this situation by using:

A regression analysis

B Markov analysis

C expected value analysis

D queuing theory

E Matrix algebra

B 10 Arlington Inc is attempting to predict the profitability of a new product line The Marketing

Department has developed three different forecasts of annual demand and their related probabilities of occurrence for the coming year—low (.2), medium (.5), and high (.3) To develop an estimate of the annual profit figure for the new product line, Arlington Inc should employ:

A queuing theory

B expected value analysis

C correlation and regression analysis

D discounted cash flow techniques

E PERT/CPM analysis

B 11 Expected value in decision analysis is:

A a standard deviation using the probabilities as weights

B an arithmetic mean using the probabilities as weights

C the square root of the squared deviations

D the standard deviation divided by the coefficient of variation

E a measure of the difference between the best possible outcome and the outcome of the original decision

D 12 A proprietor who just inherited a building is considering using it in a new business venture

Projections for the business are: revenue of $100,000, fixed cost of $30,000, and variable cost

of $50,000 If the business is not started, the owner will work for a company for a wage of

$23,000 Also, there have been two offers to rent the building, one for $1,000 per month and one for $1,200 per month What are the expected annual net economic profits (losses) to the owner if the new business is started?

1.$20,000

2.$(3,000)

3.$(15,000)

4.$(17,400)

E none of the above

SUPPORTING CALCULATION:

$100,000 - $30,000 - $50,000 - $23,000 - (12 x $1,200) = $(17,400)

C 13 A firm obtained the following data based on the results shown below for 100 runs simulating the

introduction of a new product

Net Profit Before Tax: ($5,000 ) $0 $5,000 $10,000 $15,000 Frequency: 30 30 20 15 05 The firm should:

A expect to break even if the product is introduced

B not introduce the product

C expect to make a profit if the product is introduced

D expect to lose money if the product is introduced

E none of the above

SUPPORTING CALCULATION:

Profit Probability Expected Value

$(5,000 ) 30 $(1,500 )

15,000 15 2,250

$3,250

B 14 The Prep Club sells fresh hot cider at Ivy University's home football games The frequency

distribution of the demand for cups of hot cider per game is presented below

Unit Sales Volume Probability

10,000 cups 10

20,000 cups 15

30,000 cups 20

40,000 cups 35

50,000 cups .20

1 00 The hot cider is sold for $1.00 a cup, and the cost per cup is $.40 Any unsold hot cider is

discarded because it will spoil before the next home game

The estimated demand for hot cider at the next Ivy University home football game using an

expected value approach is:

A 30,000 cups

B 34,000 cups

C 40,000 cups

D 50,000 cups

E some amount other than those given above

SUPPORTING CALCULATION:

10,000 x 10 = 1,000

20,000 x 15 = 3,000

30,000 x 20 = 6,000

40,000 x 35 = 14,000

50,000 x 20 = 10,000

34,000

A 15 The Prep Club sells fresh hot cider at Ivy University's home football games The frequency

distribution of the demand for cups of hot cider per game is presented below

Unit Sales Volume Probability

10,000 cups 10

20,000 cups 15

30,000 cups 20

40,000 cups 35

50,000 cups .20

1 00 The hot cider is sold for $1.00 a cup, and the cost per cup is $.40 Any unsold hot cider is

discarded because it will spoil before the next home game

The conditional profit (loss) per game of having 30,000 cups of hot cider available but only selling 20,000 cups of cider is:

1.$8,000

2.$12,000

3.$18,000

4.$3,000

E some amount other than those given above

SUPPORTING CALCULATION:

$1(20,000) - $.40($30,000) = $8,000

C 16 The Prep Club sells fresh hot cider at Ivy University's home football games The frequency

distribution of the demand for cups of hot cider per game is presented below

Unit Sales Volume Probability

10,000 cups 10

20,000 cups 15

30,000 cups 20

40,000 cups 35

50,000 cups .20

1 00 The hot cider is sold for $1.00 a cup, and the cost per cup is $.40 Any unsold hot cider is

discarded because it will spoil before the next home game

The conditional profit (loss) per game of having 30,000 cups of hot cider available but being able to sell 40,000 cups of hot cider if it were available is:

A $14,000

B $12,000

C $18,000

D $24,000

E some amount other than those given above

SUPPORTING CALCULATION:

30,000 ($1 - $.40) = $18,000

E 17 Boyer Company is considering designing an educational computer software package Boyer's

management is aware that this project may not be feasible, that demand for the software may be low, and that competitors may offer a similar package before Boyer does Boyer can best evaluate the possible payoffs of the computer software project by using:

A differential calculus

B critical path analysis

C linear programming

D regression analysis

E decision tree analysis

C 18 A decision tree has been formulated for the possible outcomes of introducing a new product line

.7 / - $100,000 /

#1 -\

\ - $70,000 3

.8 / - $170,000 /

#2 -\

\ - $80,000 2

Branches related to Alternative #1 reflect the possible payoffs from introducing the product without

an advertising campaign The branches for Alternative #2 reflect the possible payoffs with an advertising campaign costing $40,000 The expected values of Alternatives #1 and #2, respectively, are:

A #1: (.7 x $100,000) + (.3 x $70,000)

#2: (.8 x $170,000) + (.2 x $80,000)

B #1: (.7 x $100,000) + (.3 x $70,000)

#2: (.8 x $130,000) + (.2 x $40,000)

C #1: (.7 x $100,000) + (.3 x $70,000)

#2: (.8 x $170,000) + (.2 x $80,000) - $40,000

D #1: (.7 x $100,000) + (.3 x $70,000) - $40,000

#2: (.8 x $170,000) + (.2 x $80,000) - $40,000

E none of the above

B 19 A firm wishes to compare the effects of using a new labor-saving machine with present direct labor

methods These comparisons will be made over a wide variety of operations on several typical days The demands placed upon each operation as well as the sequence of individual operations can

be described by probability distributions The most relevant quantitative technique is:

A cost-volume-profit analysis

B Monte Carlo simulation

C Program Evaluation and Review Technique (PERT)

D statistical sampling

E time-series or trend-regression analysis

C 20 When several unit sales volumes are multiplied by the probability of their occurrence and those

products are summed, the result is the:

A median

B standard deviation

C expected value

D best estimated sales level

E average sales level

C 21 The quantitative technique that would be most useful in projecting revenues is:

A linear programming

B PERT/cost analysis

C probability theory

D learning-curve analysis

E queuing theory

B 22 Probabilistic estimates are most frequently used with which of the following methods of capital

expenditure evaluation?

A payback

B present value

C internal rate of return

D accounting rate of return

E none of the above

D 23 The measure of the variability of expected outcomes in a probability distribution is known as the:

A coefficient of variation

B standard deviation

C expected value

D variance

E none of the above

A 24 Which of the following can be computed and compared for each alternative to determine the

relative riskiness of investments that have different levels of expected return?

A coefficient of variation

B variance

C standard deviation

D expected value

E none of the above

C 25 Which of these could occur in practice where the capital expenditure relates to the production of an

established product or service, the demand for which is expected to vary in response to temporary changes in consumer taste?

A perfectly correlated cash flows

B negative cash flows

C independent cash flows

D mixed cash flows

E none of the above

E 26 In capital expenditure analysis, which of the following can be constructed to evaluate alternative

levels of investment?

A normal distribution

B bar graph

C nonnormal distribution

D pie chart

E payoff table

A 27 Which of these is useful in that it gives the manager a visual map of the expected levels of each

alternative action?

A decision tree

B Monte Carlo simulation

C Markov chain

D sensitivity analysis

E none of the above

E 28 The standard deviation of the expected net present value is determined by summing the discounted

standard deviations for each period over the life of the project when the cash flows in each of the periods are:

A independent

B positive

C mixed

D negative

E perfectly correlated

E 29 If events are related, computational procedures must be modified by substituting:

A random variables

B slack variables

C dependent variables

D independent probabilities

E conditional probabilities

A 30 An expenditure evaluation tool that explicitly incorporates both quantitative and nonquantitative

factors into the decision analysis is known by the acronym:

A MADM

B FMS

C CIM

D JIT

E none of the above

PROBLEM

1.

Probability Analysis The operator of an office building concession stand wishes to know how many doughnuts to stock each day The doughnuts cost $.25 each and are sold for $.35 each Those unsold at the end of the day have no value From past experience, the following probability distribution has been calculated:

Number of

Doughnuts Sold

per Day Probability

Assume that only the three quantities listed are ever sold and that the occurrences are random events.

Required:

(1) What is the average number of doughnuts sold per day? If the operator stocked this average

number of doughnuts each day, what would the expected daily contribution margin be? (Round to two decimal places.)

(2) Compute the variance, the standard deviation, and the coefficient of variation of the expected

value (Round intermediate calculations to 4 decimal places and round the standard deviation and the coefficient of variation to the nearest whole cent.)

SOLUTION

(1)

Average number of doughnuts sold per day 49

Expected daily contribution margin if 49 doughnuts stocked:

Expected daily contribution margin (expected value) $ 4 .12

Contribution Difference

Value) ($4.12) (2) Squared Probability (3) x (4)

$1 .8605 Standard deviation = square root(Column 5 total) = square root($1.8605)

= $1.3640

$1.36 Coefficient of variation = - = 33

$4.12 PROBLEM

2.

Decision Trees The management of Seoul Industries is trying to decide whether to build a large, medium,

or small plant at a new location Demand for the company's product in the new area is uncertain, but the marketing manager has assigned probabilities to three levels of demand These probabilities, as well as the contribution margins (conditional values, in millions of dollars) for each plant size and demand level, are

as follows:

Demand Level

Large $7 $2 $ -1 Medium $6 $4 $ 0 Small $5 $3 $ 1 Probability 3 5 2

Required:

(1) Construct a decision tree for this situation.

(2) Choose the most profitable of the expected alternatives.

(1)

Expected Contribution

/ $7 /

N / $2

A /

L / - LOW (.2) - 2

/

E /

G /

R /

/

S \ \

L \

L \ \

P \

N \

\ $3

\

(2) Based on expected contribution margins, management should build the medium plant, which has

the highest expected value